Mortgage Rates: Where Have They Been, Where Are They Going?

Where will mortgage rates be in ten years? If you knew that, you would probably be a lot more comfortable making decisions about signing up for a mortgage today. Well, no one can say for sure where mortgages will be in ten years, but by looking back at changes over the past 10 years, you can get some sense of what is likely to drive rates going forward.

Where were mortgage rates 10 years ago?

Ten years ago, in early 2005, rates on 30-year mortgages were at around 5.7 percent, according to mortgage finance company Freddie Mac. That might sound high by today's standards, but it was actually well below the norm throughout the prior history of 30-year rates.

Home buyers responded enthusiastically to those rates. The S&P/Case-Shiller U.S. National Home Price Index shows home prices, which by early 2005 had already been rising for several years, began to accelerate - racing, of course, to the peak of the housing boom about a year-and-a-half later.

What has changed?

The most obvious change from ten years ago is that current mortgage rates are about two percent lower. Why did this happen? Here are some key reasons:

Inflation. The most recent year-over-year figures show that the Consumer Price Indexrose by just 1.3 percent. This extremely low rate of inflation was helped in no small part by the collapse in oil prices last year. In contrast, ten years earlier inflation was running at an annual rate of 3.5 percent. Since mortgage lenders seek to maintain a healthy cushion over the rate of inflation, this drop in inflation is a big factor in facilitating the drop in mortgage interest rates.

Loan demand. 2005 was prime time for the housing boom, and so there was a frenzy of loan demand, which tends to support higher rates. Now, while the housing market is recovering, there is nowhere near the demand there was ten years ago.

Federal Reserve policy. In response to the collapse of the housing market, over a period of years the Federal Reserve bought hundreds of billions of dollars in bonds and mortgage-backed securities, in an active effort to drive interest rates down. While that buying program has ceased, the Fed still owns a large inventory of these securities, which helps keep rates low.

What does that say about the future?

All of that explains why mortgage interest rates have fallen over the past ten years, but it also raises some questions about whether rates can maintain their current low levels.

For example, 3.5 percent is a much more normal inflation rate than 1.3 percent. So, inflation does not have to get out of hand to push interest rates higher -- it merely has to return to normal. Since last year's low inflation owed a lot to the collapse in oil prices, you have to ask yourself whether that kind of collapse can be repeated year after year.

As for loan demand, while the housing market is not as hot as it was ten years ago, it has been rising for three years now, and recent moves to loosen lending requirements are designed to further support that recovery. Throw in an improving economy, and loan demand should at least strengthen, even if it does not return to housing-boom levels.

Finally, with regard to Federal Reserve policy, they took extraordinary measures to drive mortgage interest rates down. Those measures could not have been continued forever, and the stronger the economy gets, the more the Fed will be able to back away from its low interest rate position.

Face it: 10 years ago few would have predicted that mortgage rates would drop below 4 percent within the next decade. Similarly, there is no telling what new factors might emerge to drive inflation, loan demand, and Federal Reserve policy, and thus influence interest rates over the next 10 years. However, the more you look at how current mortgage rates got where they are, the more you can appreciate that the factors that led mortgage rates to record lows may be starting to turn around.